Dollar, China’s woes continue to haunt emerging markets

In a record stretch of bear market stocks, the emerging market stocks of Bloomberg have exceeded their rough patch during the dot-com era thanks to a surging dollar and China's growth uncertainties.

It has been 594 days since the MSCI Emerging Markets Index closed at its peak in February 2021, according to Bloomberg-compiled data. According to Morgan Stanley, the previous record was 589 days that ended in September 2001.

The MSCI EM benchmark has fallen about 39% from last year's high versus a drawdown of 66% during the global financial crisis. There is a lot of reasons to suggest that the weakness may last a long time, given an unapologetically hawkish Federal Reserve that will continue to boost the dollar and draw funds away from emerging markets.

The outlook of Chinese companies, which carry the biggest weight in the index, is uncertain due to the country's rigid Covid policy and escalating tensions with the West.

EM equities will continue to be under pressure from dollar appreciation and weak US equity markets, Jon Harrison, managing director for emerging-market macro strategy at TS Lombard in London, wrote in a note Monday. External conditions are deteriorating and EM outflows are set to accelerate. A study of global EM equity exchange-traded funds by TS Lombard shows that the cluster of stocks last month suffered their largest net outflows since the onset of the epidemic.

Morgan Stanley strategists including Jonathan Garner believe that a classic capitulation trough could be formed as EM stocks moved close to his bear-case targets and due to seasonal factors.

Garner warned on May 10 that Asia and emerging-market equities are entering the late stages of a bear market. Since then, the MSCI EM Index has dropped 13%, underperforming the MSCI World benchmark.

Six of the 10 bear markets in Asia and EM equities bottomed in September or October, Garner and his colleagues wrote in a note last month. They are monitoring 10 signals including the dollar's strength, the semiconductor sector's performance and the breadth of earnings revisions to call the current cycle low.

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